Timing the Real Estate Market
Like Warren Buffett:
"How to Become Rich"
"If you haven’t the strength to impose your own terms upon life,
then you must accept the terms it offers you."
– T.S. Eliot
Most people like to follow Warren Buffett because he is one the great investors of our time. They also like how he explains the complexities of investing in simple terms that almost anyone should be able to understand.
Warren however sometimes contradicts
himself with his investment advice.
To become rich as an investor,
for example – and this is Buffett’s most famous
quote – we are told over and over again to “be
fearful when others are greedy” and“be greedy
when others are fearful.”
Sounds like good advice to me – but this of course involves market timing.
Then in another interview Warren Buffett would have you believe that everyone should “buy and hold.” He repeatedly says that it is a big mistake to try to time the markets – and the best stock market strategy is to simply buy a cross-section of good U.S. stocks (or stock indexes) and hold them for long periods of time, and maybe forever.
Huh? Now he tells us not to time the market? What’s going on here?
“Stocks always go up in the long run,” explains Buffett, “plus I’m not smart enough to tell you when to get in and out of the market.”
But guess what? While Buffett’s first statement is true – his last statement is not.
Buffett has made a killing from market timing.
Everybody knows there’s a great deal of truth behind the investment advice to buy fear and sell greed – and Buffett has successfully employed this kind of market timing since he first started investing 70 years ago, even though he rarely talks about it.
So why the contradiction? Why does Buffett tell investors to do one thing (buy-and hold) while he does another?
My guess is because Buffett knows that market timing requires a skill that few investors have – or have the mental discipline to pull off.
It’s not easy going against the grain and shutting out the noise of the crowd … and taking actions that are contrary to the consensus. Even though this is an ability that most people simply don’t have, I am going to show you how this market timing skill has contributed to much of Buffett’s investment success.
Because markets are markets, I will also show you how the same principles that have made Warren Buffett extraordinarily successful in stocks can also be applied to real estate, and make you more successful in this investment arena as well.
How To Invest in Real Estate Like Warren:
The Value Investor
The best investors in the world have a well-defined plan they stick with through thick and thin – and Warren Buffett meets this criteria.
What’s his plan?
He’s what’s known as a “value investor” – which is a strategy of actively seeking out (and buying) good stocks that Buffett believes are undervalued.
While Buffett believes the long-term trend will continue to push stock prices higher and higher, he’s also savvy enough to know that the emotions of fear and greed will generate a series of short-term trends (inside the long-term trend) that will cause the price of a stock (or index fund) to fluctuate from being undervalued and overvalued at different points in time.
By being patient, value investors like Buffett try to be “greedy when others are fearful” and buy stocks of good companies when they are selling at distressed prices – and are undervalued relative to their long-term upward trend.
According to Buffett, the best thing that can happen is when great companies get into temporary trouble. We want to buy them when they’re on the operating table.
The above chart illustrates Buffett’s strategy – and how he would apply his “value” principles to real estate investing. The straight line reflects the long-term trend for housing prices and the line that oscillates above and below the straight line reflects the actual path that housing prices take over time.
There is no way to know what’s going to happen in the future, so Buffett would tell you that insisting on a “margin of safety” – i.e. buying an asset that is below the long-term trend line – is the best approach for the value investor. The larger the margin of safety is, the higher the probability of success.
An Understanding of Cycles is Needed
To be a superior real estate investor, you must have respect for the market cycles. Up and down cycles will never stop occurring because human nature will never change. Markets are driven by people – and people are driven by fear and greed.
That’s why the cycles fluctuate between doom and gloom and euphoria. The happy medium is a line that is upward sloping – but in reality the markets spend very little time on that line. As the pendulum swings back and forth, this is what creates tremendous opportunities for astute investors like Warren Buffett who is not only aware of the swings in the market – but understands they are driven by extreme levels in investor emotion (fear and greed).
Paradoxically, high prices create their own seeds of failure – and low prices create their own seeds of failure. That’s why real estate cycles have a way of being self-correcting – and even though average thinkers believe most trends will continue forever – they can reverse on their own because of market psychology as opposed to outside events.
The above chart was created by Yale economist Robert Shiller – who is one of the co-developers of the Case-Shiller home price indexes. It shows a 126 year history of inflation-adjusted U.S. housing prices and how they have repeatedly cycled from boom to bust to boom since the 1970’s.
Where Warren Buffett (the “value” investor) would optimally try to make his real estate investments are identified by the arrows that point to market cycle lows – and I’ll show you how to identify these low points in the cycle a little later.
“Look at market fluctuations as your friend rather than your enemy,” says Warren Buffett. “Profit from folly rather than participate in it.”
A Sense for Value is Needed
To be a great investor like Warren Buffett, you must have a sense for value. No asset (including real estate) is so good that it can’t become a bad investment if bought at too high a price – and there are hardly any investments that aren’t good if they are not bought cheaply enough.
Many successful investors will tell you that investing is like a popularity contest – and it’s absolutely true.
The worst time to buy an investment is at its point of peak popularity. Everyone that is going to buy has already bought – and the price of the asset has almost no place to go but down.
The best time to buy is when an investment is when it is least popular and no one wants it. At that point, everyone that wanted to sell has already sold – and the price has usually nowhere to trend but up.
Buffett would tell you that knowing value is
the most important thing you must understand if you
want to be a successful investor.
Buying at a price below the real worth of an
investment explains the Buffett’s concept of buying
with a “margin of safety” – and doing this is the most reliable approach to making an investment profit.
To achieve extraordinary investment results, your understanding of value has to be extraordinary. Real estate investments that are overvalued should be avoided or sold. Those that are undervalued should be considered for purchase.
Or as Buffett would say: “Whether you are buying socks or stocks, I like buying quality merchandise when it is marked down.” With real estate, that is done by purchasing properties at market cycle bottoms – when fear is running rampant.
An Understanding of Risk is Needed
Managing risk is another mark of the superior investor. Managing risk is not risk avoidance. All investments have some good years and bad years – and therefore the benefits of managing risk generally come in the form of losses you don’t experience.
Risk is actually high when everyone believes it is low – and it’s lowest when
everyone thinks it is high.
That’s because overly optimistic
investors bid up prices to levels that are too
high during the good years – which
increases risk and makes investors
vulnerable to significant losses.
During the fear side of the cycle, overly pessimistic investors keep cutting their asking prices to levels that are too low during the bad years. This reduces risk and provides a large potential for future reward.
In other words, you want to take risk when everyone is running away from it – and not when investors are aggressively bidding up prices to take it on.
The mantra everyone cites for successful real estate investing has always been location, location, location. But that’s not always true. Instead, investment success is a matter when you buy a property and the price you pay for it – whether it is well-located or poorly located.
To investors like Buffett, his mantra for real estate success would be "value, value, value."
Well-located properties can be risky and wipe investors out if they are purchased at a price that is too high at the wrong time.
Properties that are in poor locations, however, can be fantastic investments if they are purchased at a bargain price at the right time.
Real estate bargains have nothing to do with location. A good location can be a good or bad investment. It all depends what you pay for it.
And oftentimes the best action is no action at all. Waiting for lower prices is often the prudent strategy.
Would a value investor like Warren Buffett tell you that achieving the greatest level of success in real estate investing is not about location, location, location? I’m confident he would.
Instead he would say that superior real estate success is more dependent on understanding risk (market sentiment), on understanding market cycles (timing), and on not overpaying when you buy an asset (value).
Average Thinking vs. Superior Thinking
If you want to be a superior investor, you can’t do what everyone else is doing and expect to outperform.
But it’s not enough to be different – what you do has to be correct. As a value investor in real estate, you will be running against the herd at major turning points in the market – and that’s not easy to do. But this is what will make you different from the average investor – and lead to superior long-term performance.
The average thinker says: “Real estate prices have really gone up a lot in the last four years. Let’s buy something.”
The superior thinker says: “Real estate prices
have risen too high and too fast in the last four years.
We should consider selling a couple of our rental
The average thinker says: “The experts say
the real estate market is really bad – and they don’t think
it’s going to get better for a long time. We should sell
now before it gets worse.”
The superior thinker says: “People are too pessimistic about the housing market. I think we are close to a bottom. I’m going to buy.”
Being a superior thinker isn’t something you pick up from a book or master right away – if ever. However having a solid understanding of the cyclical nature of real estate prices – and how they move from being under-valued to over-valued over time – is an excellent start.
Call it contrarian investing, being a superior thinker or whatever you want, but here are a few things that can help you outperform over time – and set you apart from other investors:
1. Price is different than value. Any piece of real estate can be a good investment
at one price and a lousy one at another price.
2. Think in terms of probabilities, not certainties.
3. You can control the decision-making process, but you can’t control the outcome.
No one knows what the future holds.
4. Avoid huge mistakes – like buying at or near market cycle peaks.
5. You don’t have to work harder than other investors – just be smarter and more patient.
6. Everyone is a genius during a bull market but downturns are going to come.
And lastly, understand that no one has all the answers – and you’ll never be able
to outsmart the real estate market all the time. Investment success is a marathon – not a sprint.
Warren’s Market Timing Model
“Be fearful when others are greedy and be greedy only when others are fearful” has to be Warren Buffett’s most famous quote.
This advice, however, is not easy to put in practice for most investors.
How do you know, for example, what investors are actually doing with their money – namely whether they are acting out of fear or out of greed?
Buffett knows that value matters. He is therefore invested in stocks most of the time – but not always. That’s why he uses a very complicated valuation model to determine when stocks get overvalued.
When stocks do get overvalued, Buffett knows that it’s a good idea to invest in something else (like bonds).
Market researchers have run the numbers on what they know about Buffett’s valuation model – and looking only at year-end data from 1950 on, calculated how well an investor would have done if they followed the model.
They found that $1,000 grew to roughly $1.15 million from 1950 to 2015 using the Buffett valuation/timing model – as compared to the $720,000 that a buy-and-hold stock market investor would have made. And what if you only invested in bonds during those 65 years? You would have made $32,000.
While the calculations may be complex, the concept behind Buffett’s timing model is very simple. You buy stocks when they’re not overvalued – and when they are, you buy bonds.
This doesn’t mean Buffett sells all of his stocks when they are overvalued and runs for the hills. Instead he might simply underweight stocks and overweight bonds based on what his model is telling him. Or as new money comes in, he might just invest that money in bonds until stocks came down in price and become a more attractive opportunity again.
Moving now to real estate investing, how can you tell when to be fearful and when to be greedy? When property is overvalued – and when it is undervalued?
That's very hard to do -- unless you have a model.
My book Timing the Real Estate Market gives you a timing model for identifying the approaching peaks and valleys of real estate cycles.
You’ll know when properties are overvalued, and should be backed away from or sold – and when properties are undervalued, and should be bought.
The human element is core to the Buffett strategy. Not only do you have to recognize when the other market participants are being too greedy or fearful – but you have to combat your own fear and greed as well. This is not easy to do.
While there is no surefire recipe for always being successful in the markets, Warren Buffett gives you the principles to increase your returns and lower risk.
To outperform as an investor, Buffett says you must think about market psychology (fear and greed), be attentive to cycles, and seek out bargains (value). He says an investor must also understand risk – and know that it increases during market upswings and decreases during market downswings.
His strategy is more complex than that, but not by much.
The difference between Buffett and most investors isn’t his higher I.Q. It’s that he has created an investment strategy for navigating him through the up and down cycles of the market. By doing this, he avoids most of the big mistakes that hurt other investors.
Do you have a Buffett-like plan for real estate success?
With a timing model, real estate investors can put Buffett’s investment strategy into practice with minimal effort.
The question is, do you have a timing model that can guide you through good times
If you don’t, you won’t know when to buy fear and sell greed in the housing market.
But if you do have a real estate timing model – and that’s what my book Timing the Real Estate Market is all about – you can be one step ahead of other real estate investors and outperform them with higher rates of return.
CLICK HERE to buy Timing the Real Estate Market.
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